October 10, 2008 | posted by Michael Baxter in banking rescue plans, stock market crashes |

The golden rule of investing, or so they say, is to sell when you feel the time is right, never sell because you have to. Put it another way, never, never use your share portfolio as a bank account.

That is all very well, but no one lets that happen deliberately. Events, dear boy, can change everything.

It seems unlikely that many billionaires expect to suddenly find they don’t have enough cash, and need to liquidate stock.

It seems unlikely that local authorities expect to discover their money saved away in Icelandic bank accounts may be worthless.

By close of play this afternoon, it seems probable we will have witnessed the worst 24 hours seen yet in this finance crisis.

Read on for our account of this most dramatic day so far.

This morning, shares in Asia crashed. The Nikkei 225 fell 11 per cent; shares in Australia saw their biggest one-day loss since 1987; the Hang Seng shrunk by 8.5 per cent; and India’s Semsex index collapsed 9.6 per cent.

But this isn’t like 1987. 1987 came from nowhere, and the crisis ended almost as quick. The losses that are occurring right now, as you read these words, come on top of previous days of catastrophe. To highlight the way losses are compounding upon previous losses, consider this. Ten days ago, the Dow Jones fell by 777, or by 7 per cent. It was the biggest percentage fall in one day since 1987. Yesterday the Dow fell by 678 points – or a drop which was 99 points less than last week’s black day. But the Dow has fallen by so much since then, that in percentage terms, the fall was even bigger – 7.3 per cent in fact.

It seems that several key reasons lie behind yesterday’s falls.

First off, there is growing realisation that the global economy is on the edge of recession. The IMF spooked the world when it revealed its latest projections for economic growth. It now expects the US to expand by just 0.1 per cent next year, and the Euro areas by 0.2 per cent. The UK is expected to contract by -0.1 per cent, but even the economies of China, India, Brazil and Mexico are expected to slow significantly – although China is still expected to expand by 9.3 per cent, so that’s still pretty impressive.

Then, this morning, official data revealed Singapore is now in recession – it’s the second country from that end of the world to be so tarnished – New Zealand has been in recession for a while.

Shares in GM and Ford tanked – down 31 and 21 per cent respectively, after credit rating agency Standard and Poor’s put the two companies on credit watch negative. It is not difficult to guess why; the prospects for auto sales in the US next year are just plain awful. Shares in GM are now at their lowest level since 1950.

Then a rather nasty penny dropped. You know of course that Lehman Brothers has gone bust. What you may not know, but will probably not be surprised to learn, is that much of the bank’s debt was insured. For that matter, so was much of Icelandic bank debt.

Okay, it’s a tangled web, and a lot more complicated than that. But, sitting in the middle is a spider called Credit Default Swaps. The market for these instruments is simply massive – worth around $55 trillion, or just under £10,000 for every person on this planet.

Sorry, let’s run that past you again, the Credit Default Swaps market is worth £10,000 for every man, woman and child on this planet, including the several billion people who earn less than $1 a day.

Okay, no one is talking about the collapse of the entire market, but today is the day that swaps related to Lehman Brothers are up for auction, and when that is over, owners of these defaults will know how much money they can claim, and banks are worried – very worried. They have known this was coming for some time, which is one of the reasons they have stopped lending to each other; they have needed every penny they could lay their hands on.

Then, of course, short-sellers get the blame. The short-selling ban in the US ended yesterday – but to be honest, this argument is a no-starter. For one thing, short-selling is a zero sum game. For every short-seller there is a long-seller, so really, short-selling’s effect on markets should be fairy miniscule. Besides, short-sellers make their money through correctly second-guessing the market. They try to anticipate what is going to happen. They no more influence the global stock market, than surfers influence the tide.

But perhaps the intriguing reason given for yesterday’s sell off is that some billionaires are being forced to liquidate their stock in order to meet their commitments.

Earlier this week, one theory doing the rounds was that markets would not fall much further, for the simple reason that the only shareholders left are long-term shareholders who will never sell. Well, if some of these long-term shareholders have lost money because their cash was in Iceland, or are billionaires who can’t afford to pay their bills, then that argument no longer applies.

Don’t forget, earlier this decade, a quite ridiculous rule imposed on pension funds exacerbated the stock market falls of that period. Rules on pension fund solvency meant that as share prices fell, pension funds were forced to sell stock, in order to meet solvency rules. In effect, they were forced to sell when markets were near bottom. This may have then caused markets to fall even further, creating a new, unnecessary bottom. As a result, they lost out on much of the benefits from the recovery. Rules designed to reduce risk, actually cost pension funds, and consequently us all, a fortune.

No doubt we will see a repeat of that particular form of madness soon.

So far, billionaires in trouble have not been named, with the exception, that is, of Robert Tchenguiz, the property tycoon who owns Icelandic bank Kaupthing.

According to The Times, Mr Tchenguiz remains solvent, but of course this all begs the question, will he be forced to sell his British property portfolio?

So what can be done? Gordon Brown is busy rebuilding credibility as he tries to present himself as the leader of a global effort to fight back.

But what can be done? What have we learnt from the 1930s? Read on.